Integration, cointegration and the forecast consistency of structural exchange rate models.

Exchange rate forecasts are generated using some popular monetary models of exchange rates, in conjunction with several estimation techniques. We propose an alternative set of criteria for evaluating forecast rationality, which entails the following requirements: the forecast and the actual series i) have the same order of integration, ii) are cointegrated, and iii) have a cointegrating vector consistent with long run unitary elasticity of expectations. When these conditions hold, we consider the forecasts to be "consistent". These criteria appear to be more appropriate for forecasts generated by structural models than typical measures of forecast rationality, since such models rely upon serially correlated measures of the fundamentals.